Who will control L&T? Birlas or the 'professionals'?
A battle royal has broken out to control the management of Larsen & Toubro, one of India's largest engineering and construction companies with more than 25,000 employees and an annual turnover in excess of Rs 8,350 crore (Rs 83.50 billion).
The tussle relates to control over the company's cement manufacturing facilities.
The outcome of the conflict could have far-reaching consequences for the country's corporate sector by determining the course and the ground-rules of future takeover attempts, of hostile as well as friendly varieties.
Much depends on the decision of the Securities Appellate Tribunal on the legal dispute relating to the public offer of L&T shares proposed by Grasim Industries (formerly Gwalior Rayon and Silk Mills) belonging to the Aditya Vikram Birla Group.
The dispute comes up for hearing on Wednesday, November 27.
Whereas the A V Birla Group - headed by the late tycoon's son Kumar Mangalam Birla and his mother Rajshree Birla - has its own plans about how L&T's cement business should be hived off, the professional management of L&T -- led by CEO and Managing Director A M Naik and Deputy MD A Ramakrishna -- has completely different ideas about how L&T's cement operations should be de-merged from the main company.
A parallel has been drawn between Grasim's attempt to control the management of L&T and the Gujarat Ambuja group's purchase of a 14.45 per cent stake in ACC (formerly Associated Cement Companies) from the Tata group.
While the two episodes are not exactly identical, it cannot also be denied that there are striking similarities.
In both instances, a competitor has apparently sought to control the management of its rival by purchasing a relatively small chunk of shares at an exorbitant price.
In both the ACC-Gujarat Ambuja case as well as the L&T-Grasim case, the competitor has appointed its nominees on the board of directors of the rival company leading to charges that managerial control has changed hands.
The third similarity is that in both episodes, minority shareholders are claiming that they have been short-changed and are being denied the high prices paid to acquire the initial stakes in both ACC and L&T. That's not all.
Both ACC and L&T are supposed to have independent professional managements.
Government-controlled financial institutions hold the largest chunk of the equity capital of both companies, while public holdings in both companies are close to one-third.
This is where the similarities stop and the differences begin.
Some differences too
Whereas the Gujarat Ambuja group claims it is merely a 'strategic investor' in ACC and does not overtly control its management, the steps initiated by Grasim clearly indicate that it wishes to control the management of L&T though it has not explicitly said so.
Which side will eventually win in the ensuing power struggle remains to be seen, but what is clear is that the regulatory authority - the Securities and Exchange Board of India - will have to quickly settle a couple of vexatious questions pertaining to the smooth functioning of the 'takeover code,' more formally known as the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997.
These questions are as follows.
Can a group of individuals or corporate bodies be the single largest shareholder in a company and still not control its management?
Alternatively, can those who control the management of a company not hold any - or a very small proportion -- of the company's shares?
In other words, will it be feasible or practical for a market regulator like Sebi to define the size of the shareholding stake of a promoter or a group of promoters before the particular promoter or group is able to control a company's management?
This shareholding proportion varies from country to country and from situation to situation. Nevertheless, a related issue would be whether this proportion should have any bearing on the 'trigger' for a public offer.
Currently, as per Sebi guidelines, if a particular individual, company or group of companies purchases 15 per cent of the equity capital of a company at a certain price, a public offer has to be made to all existing shareholders to purchase up to 20 per cent of the company's shares.
Now comes the pricing issue. If the purchase of 15 per cent or less of a company's shares results in a change in management control, the existing shareholders have to be paid for their shares a price that is not less than the price paid to acquire the initial stake.
If, on the other hand, despite the purchase of 15 per cent -- or even a higher proportion - of a company's shares there is no change in management control, the price offered to existing shareholders should be the average price prevailing over the last 26 weeks or two weeks preceding the public offer, whichever is higher.
As for the meaning of control, Sebi guidelines define the word to mean 'the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders' agreements or voting agreements or in any other manner.'
No violations, says Grasim
The A V Birla group argues that it has not violated Sebi's takeover code.
Journalists have quoted a Grasim spokesperson as saying: "Grasim has complied with all regulations and acted according to the highest standards of corporate governance… We are strongly convinced about our legal rights."
On November 21, Grasim's lawyers sought an interim stay on Sebi's November 11 order putting on hold its plans for an open offer of up to 20 per cent of L&T's shares that had been public announced on October 13 - interestingly, at a time when both Naik and Ramakrishna were out of the country.
Whereas the public offer was to open on December 9, Sebi's lawyers claimed before the SAT on 21 November that it had fresh evidence to justify its direction to Grasim to stay its public offer of L&T shares.
The entire episode would not have generated controversy if on Sunday, November 18, 2001, Grasim had not purchased 10.05 per cent of L&T shares from the Ambani-family controlled Reliance group at a price of Rs 306.60 per share.
This price was around Rs 100 or 47 per cent higher than the then prevailing market price of a share of L&T.
On 24 November 2001, Kumar Mangalam Birla and Rajshree Birla were inducted on the board of directors of L&T.
On 27 December that year, Sebi sought details of the Grasim-Reliance share deal following allegations of 'insider trading.'
The total sum paid by Grasim to Reliance worked out to Rs 766.5 crore (Rs 7.665 billion) and the latter reportedly booked hefty capital gains to the tune of Rs 360 crore (Rs 3.60 billion) on the transaction.
As early as 1987, the Reliance group had acquired 18 per cent of L&T's shares. Subsequently, the Ambani family patriarch, the late Dhirubhai H Ambani became the Chairman of L&T.
Ambani had to relinquish his post in May 1990 when the then Union government headed by Vishwanath Pratap Singh prevailed on a group of public financial institutions led by Life Insurance Corporation to use their shareholding clout in L&T to seek the resignation of Ambani from the chairmanship of the company.
Having just emerged then from a bruising battle with The Indian Express newspaper, Ambani was replaced as L&T chairman by the former Chairman of the State Bank of India, D N Ghosh.
Between 1987 and 1993, the Reliance group was L&T's single largest customer.
During this period, the group set up two major manufacturing facilities - a petrochemicals complex at Hazira and a petroleum refinery at Jamnagar.
To return to the allegations of insider trading, the Reliance group's holding in L&T had varied between 4 per cent and 10 per cent before it sold its stake to Grasim.
Under the Sebi lens
Sebi is currently investigating whether or not the Reliance group increased its holding in L&T just before it was sold to Grasim on the basis of 'privileged inside information.'
Whereas Grasim purchased the shares at Rs 306, the average price of the L&T scrip had stood at roughly Rs 248 over the preceding two years.
It is said the Reliance group purchased large numbers of shares of L&T from the market at prices varying between Rs 164 and Rs 208 per share.
Further, the Reliance group reportedly increased its stake in L&T 'suddenly' from a little under 4 per cent to just over 10 per cent weeks before it sold its stake to Grasim.
Hence, the charge of insider trading that is still being adjudicated by Sebi.
Sebi is said to have told the SAT that is was investigating whether the Reliance group exercised managerial control over L&T before it sold its stake to Grasim.
Earlier, Sebi had held the Reliance group guilty of a 'technical' lapse for not disclosing the fact that its stake in L&T had crossed the 5 per cent mark.
The market regulator even levied a token fine of Rs 475,000 on the Reliance group for this lapse.
The question that is being raised is that if Sebi has found discrepancies in the manner in which the Reliance group upped its stake in L&T and levied a fine, should it not also have cancelled the Grasim-Reliance share transaction altogether.
This is an issue that has been raked up by Kirit Somaiya, Bharatiya Janata Party Member of Parliament from south Mumbai and a moving force behind the Investors' Grievances Forum that has lodged petitions with Sebi in, both, the ACC and the L&T cases.
In fact, it is being argued that Sebi had to take action on the basis of these complaints because of Somaiya's high profile.
Another question being raised pertains to the delay in making public Sebi's order restraining Grasim from going ahead with its public offer.
Whereas Sebi informed J M Morgan Stanley, the merchant banker to the Grasim public offer, about its decision on 8 November, this fact was not disclosed for ten days. Sebi and J M Morgan Stanley are now said to be blaming each other for the delayed disclosure.
To return to relations between Grasim and L&T, it has been reported that the financial institutions were initially quite happy with the presence of the two Birlas on the L&T board.
In fact, Somaiya says one of the financial institutions (the former chairman of the General Insurance Corporation) specifically wrote to L&T asking for the induction of the two Birlas on the company's board before they formally replaced the two Ambani brothers, Mukesh and Anil, on the L&T board on November 24, 2001.
However, relations between the Birlas and the financial institutions seem to have soured when the latter realised that they would not be able to sell their L&T shares to Grasim for more than Rs 190 a share.
Yet, Grasim seems to have played by the rulebook. If one considers the average price of the L&T scrip over the 26 weeks preceding the announcement of the public offer, the prescribed minimum offer price would be just under Rs 175.
Over the past year, Grasim and one of its wholly owned subsidiaries gradually acquired an additional 5 per cent shares of L&T and informed the stock exchange authorities once the 15 per cent threshold limit was crossed.
It is not clear why sections of the L&T management and the financial institutions have expressed 'surprise' at the A V Birla Group's attempt to acquire managerial control over L&T.
As the tussle heated up, both camps used journalists to 'plant' stories showing one side in a favourable light while depicting the other as the villain of the piece.
Thus, Grasim sources have claimed that the directors of L&T were not properly informed about the current status of the company's receivables, loans and assets.
These unnamed sources have pointed out that L&T has been without the services of a full-time chairman for as long as 12 years.
They claim that the so-called professional managers at the helms of L&T are keen on retaining control over a vast fiefdom without being accountable for their actions.
Those on the other side of the fence, however, argue that they wish to block the Birlas' attempt to muscle into a 'professionally managed company' without paying all stakeholders of L&T the exorbitant price that had been paid for the Reliance group's 10 per cent holding.
These sources claim that the quantum of L&T's receivables have gone up of late because of the problems being faced by the steel industry and that this is not an unusual phenomenon.
The financial institutions, led by LIC and the GIC, are also reportedly planning to undertake open market purchases of L&T shares to increase their stake.
At present, all financial institutions put together hold more than 36 per cent of the company's equity.
Meanwhile, both camps have drawn up their respective plans to de-merge the cement operations from the main company.
The A V Birla Group claims the L&T management's plan to set up a new company for its cement operations in which L&T would hold around 70 per cent shares would not be in the interests of the Birla group.
The group, in turn, has proposed what it claims is a more shareholder-friendly plan by which existing shareholders of L&T (including the Birlas) and not the company would have a higher stake in the proposed new corporate entity.
Since July 2000, the L&T management has unsuccessfully attempted to hive off its 15.5 million tonnes per annum capacity cement manufacturing facilities into a separate corporate entity since it was not considered to be a 'core' element of the company's civil engineering and construction businesses.
As a matter of fact, L&T's CEO A M Naik had at one stage even offered to sell a controlling 37.5 per cent stake in the proposed cement company to the A V Birla group, but the deal never came through.
It was said that the engineering and construction businesses of L&T did not fit in well into the A V Birla Group's corporate strategy and that Kumar Mangalam Birla was basically eyeing the company's cement division.
A matter of control
More importantly, the Birlas apparently did not want multinational corporations like Lafarge and Cemex to gain control over L&T's cement division.
At the end of the day, it all boils down to control over the country's lucrative cement market. The two corporate combines of ACC-Gujarat Ambuja and L&T-Grasim would together account for more than half the total cement manufacturing capacity in the country.
In recent years, consumers of cement (including associations of builders) have often accused cement companies of forming cozy cartels to rig prices and earn extra high profits.
At one stage, builders in Mumbai had even threatened to stop all construction activity unless the government intervened to check so-called price manipulation by manufacturers.
The Monopolies and Restrictive Trade Practices Commission has also investigated the activities of cement companies.
Cement is not easy to import or transport over long distances. Hence the presence of two large conglomerates would make eminent 'business sense' to the concerned players in the absence of a new competition law to replace the outmoded and toothless MRTP Act.
That's the bottomline and that explains the keen interest with which the Indian corporate sector is awaiting the outcome of the battle to control the management of L&T and the SAT decision on whether the Gujarat Ambuja group actually controls ACC.
The author is director, School of Convergence @ International Management Institute, New Delhi, and a journalist with over 25 years' experience in various media --- print, Internet, radio, and television.